Give Me A Break!

The Senate Investigations Sub-Committee looking into the financial collapse of late 2007 has released its findings.  Here is the opening of a CNBC story posted last night.

Conflicts of interest, excessive risk-taking and failures of government oversight triggered the financial crisis and helped push the country into the deepest recession since the Great Depression, concludes a new report by the U.S. Senate.

Getty Images The Goldman Sachs booth on the floor of the New York Stock Exchange

The two-year, bipartisan probe by the Senate Investigations Subcommittee examined the economic crisis and the role played by Wall Street in creating it.

The Republican and Democrat co-chairs of the committee agree on its findings.

"The report tells an inside story of economic assault that cost millions of Americans their jobs and their homes while wiping out investors, good business and [the] market," said Sen. Carl Levin (D-Mich).

"It shows without a doubt that lack of ethics in some of our financial institutions who embraced known conflicts of interest to accomplish wealth for themselves, not caring about the outcome for their customers," said Sen. Tom Coburn (R-Okla).  http://www.cnbc.com/id/42576329

All of this is true but, not surprisingly, they left out the part that Congresses controlled at different times by both major political parties and Administrations from both parties played in creating the economic and regulatory environment that made all of these "conflicts of interest, excessive risk taking and failures of government oversight" possible.  The government failures they cite were reserved for various regulatory agencies, such as the Office of Thrift Supervision and, to at a far lower level of culpability, Fannie Mae and Freddie Mac.

In the report, they also don't lay blame properly at the thousands and thousands of home buyers who bought far more house than they could afford to pay for ever in their lifetimes.  I guess Senators believe it's somebody else's fault when a borrower knowingly claims more income or fewer debts than they actually have in order to qualify for a nothing-down, declared-income mortgage that put them into a $500,000 house when what they could afford was a $250,000 house.

Give me a break.  Asking Congress to investigate and report on the financial meltdown associated with the collapse of the housing bubble/mortgage debacle is akin to asking Mr. Fox to investigate and report on the Great Chicken Coop Raid that decimated the flock.

How did this happen?

It started decades ago when the home loan business shifted from a market in which lenders approved, funded and collected the loans they made, to a market in which loan originators made and sold loans to packagers who securitized them as mortgage-backed bonds and resold them to investors, individual and institutional, all over the world.  This phenomenon grew and grew to a point that almost all mortgages were processed in this fashion.

Then the most recent real estate boom started and home values starting escalating really, really fast.  Loan originators kept making and selling loans with fewer and fewer requirements so more and more people could afford to buy homes, which is just what Congress intended.  Among other things, in 1999, a Republican-controlled Congress passed and then-president Clinton, a Democrat, signed a bill requiring Fannie Mae and Freddie Mac to make higher-risk loans to less qualified buyers.  That proved to be a really bad idea but at the time an overwhelming majority of our politicians of BOTH parties thought it was really the cool thing to do.

At the same time, the government decided it was cool to lower the capital requirements of these big financial specialty firms.  In some cases the new standard was an incredible leverage ratio of 30:1.  Yeah, if you realized that meant they had capital equal to a little over 3% of assets, you did the math correctly.  That meant if the value of their CDO (Collateralized Debt Obligations) portfolio fell by 4%, they were insolvent.

During this period, home buyers bought homes in which they planned to live and they bought vacation homes and they bought homes speculatively as investments.  They did so because the qualifying standards were relaxed more and more: No down payment required; no verification of income; no credit checks; crazy adjustable-rate mortgages with terms such as 3.0% for the first eighteen months, at which time the interest rate would jump to 10.0%.  People kept getting the mortgages and buying the houses because, hey, they had eighteen months to worry about refinancing or selling the house.  Besides everybody KNEW that the house was going to double in value in eighteen months--didn't they?

So they thought.  They were wrong.

The problem with that strategy was that as home values flattened and mortgage rates reset, homeowners and investors starting defaulting.  Oh, wait--that's not supposed to happen. No but it did.

As mortgages defaulted and home values fell, the collateralized mortgage obligations that included them began to fall in value and were required by SEC regulations, to be marked to market.  As bond holders needed cash, they needed to sell those bonds, NOW.  Other more well-capitalized holders were able to continue holding but they, too, had to mark the bonds to market, which caused their capital to fall.  The death spiral had started.

With me, so far?  OK, it's time to go back to Mr. Fox and the Chicken Coop.

The excessive risk taking, greed and stupidity cited by the Senate Investigations Sub-Committee in their report were real.  The SEC did a poor job of supervision of many of the big investment banks, such as Goldman Sachs, Bear Stearns and Lehman Brothers.  The OTS did a poor job supervising big savings banks, such as WAMU.

However, the failure of the Senate Investigations Sub-Committee to include Congress and various Administrations in the blame is ludicrous in the absurd.

The Budget Mess Is, Well, A Mess!

Our Federal Government has been broke for a long time.  That is, of course, if you define broke as spending (federal expenditures) far more money than you have (US Treasury) or are likely to earn (tax revenues).

If our Federal Government was a family in similar circumstances, it would have to do just what you or I would do in order to survive.  We'd cut spending to a level consistent with our ability to pay or borrow enough to pay the mortgage and buy the groceries until we could reduce spending or increase our income.

The problem with our Federal Government is it isn't a family and it doesn't play by the same rules that apply to you and me.  If the family wanted to borrow to cover its cash shortage, it could only borrow an amount consistent with its ability to repay and the loan would only be a short-term solution.  If the family overextended itself by borrowing more than it could repay, the house of cards would eventually collapse and foreclosure, bankruptcy and possibly homelessness could follow.  During the real estate boom during the middle of the previous decade a lot of folks learned all about this outcome.

Our Federal Government's rules are very different.  If it wants (notice I said wants, rather than needs) to spend more money than it has, it too can borrow.  The difference is, unlike most families, lenders seem willing to loan any amount for which the government is foolish enough to ask.  Our government, the borrower, and the buyers of US Treasury securities, the lenders, appear to believe the house of cards can and will never fall.  The reality is it would fall eventually but that's a longer-term problem.

There is, however, one real limit to how much the Feds can borrow.  It's called the Federal Debt Ceiling, which is about to be reached.

Since the government is unwilling (notice I said unwilling, rather than unable) to cut its spending to match its earnings and since the Feds are about to hit the Debt Ceiling, our government is about to stop paying many of its bills.  The only way to stop the shutdown is for Congress and the Administration to agree on a new, higher Debt Ceiling and various funding resolutions that will authorize payments.

Seems pretty simple, doesn't it?  It should be.  The problem is Congress can't agree on future spending and the Administration isn't helping.

Before I go any farther, I need to remind everyone this isn't a Democrat or Republican issue.  It's a national issue affecting all of us.

On one side (the Democrats) we had a proposal to trim the budget by a whopping $13 billion, to which the other side (Republicans) cried, "Foul!"  That's a lot of money, isn't it?  Not really.  It represents about 1/3 of 1 percent of the total proposed 2012 budget of $3.7 trillion.

On the other side (the Republicans) we had a proposal to trim the budget by an even more whopping $61 billion, to which the Democrats cried, "Foul!"  Come on--$61 billion out of a total budget of $3.7 trillion represents only 1.6% of spending.

Are the Democrats telling the Republicans and the taxpayers they can't find 1.6% of the budget to trim?  Could you reduce your family's expenditures by 1.6% next year.  Well, yeah.  We all can and have.

Quite frankly, the $61 billion reduction proposal is not nearly enough.  If it were three or four times that amount, it would be a good start.  The proposed 2012 budget deficit is $1.1 TRILLION.  That's an enormous 30% of proposed expenditures or 42% more than projected revenues.

Returning briefly to the $3.7 trillion budget figure, if you think that is a large number, you're right.  It is almost exactly double the total proposed expenditures of the Federal Government in 2001, only a decade earlier.

If the Federal Government shuts down on Friday, which is not improbable, remember why.  The Republicans didn't ask for nearly enough and the Democrats are rejecting reality as well as reasonableness.  It appears the only thing wrong with government is politics.